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Henry Hub pricing and Brent slump create LNG buyer’s market

The new pricing system in global liquefied natural gas (LNG) markets was intended to offer a lower-cost alternative to oil-linked sales contracts. As oil prices have slumped and a global LNG supply glut persists, it has become a buyers’ market

When Cheniere Energy’s first shipment of LNG finally leaves its Sabine Pass gasification plant in Louisiana in late February or March, it will mark a new era of LNG exports from the US lower 48. The internationalisation of Henry Hub pricing is on its way – and it’s already influencing global prices. After the slump in Brent oil prices, though, it is no longer the only factor set to drive LNG prices lower.

The Department of Energy’s approval of US LNG export projects – made viable by surging domestic gas production over the past decade - has been a lengthy process and was expected to provide a cheaper alternative to oil-linked sales contracts, especially for LNG-hungry Asia.

The long-awaited Trans-Pacific Partnership free trade deal signed between the US and 11 other countries was also sealed in October, with the aim of making it easier for US LNG exporters to access major new markets, especially Japan.

But the crash in Brent crude futures prices has made Henry Hub-based pricing for LNG contracts look a lot less attractive than it once did. The incentive for buyers to switch from oil-linked contracts has diminished.

Unexpected complications

Cheniere says Sabine Pass’s first 4.5m tonnes per year (t/y) train will be followed by three more trains coming online every six to nine months, eventually bringing total capacity to 18m t/y.

The project will produce around 2bn cubic feet per day of gas at its peak and will be among the largest liquefaction plants in the world.

Supplies from Sabine Pass will have a Henry Hub-linked pricing formula and tolling model in which producers pay a fee to run gas through the liquefaction plant, instead of having to own a stake in the plant itself.

The company says it has sold around 7.62m t/y so far under long-term contracts from the first two trains at a fixed fee of $3.50 per million British thermal units (/m Btu), plus an LNG cost of 115% of the Henry Hub price.

But Cheniere has yet to reach a final investment decision on the third train and the wider oil market turmoil has raised complications. This is especially true for buyers in Asia, where LNG prices have plummeted over the past year.

US natural gas production

A bearish dynamic stemming from oil has gripped LNG buyers too as Brent’s decline may still have some momentum to see out. So LNG importers conscious of forecasts for a possible drop to $20/b are now reluctant to commit to new Henry Hub-based pricing, say LNG-market sources. 

But buyers taking LNG on Henry Hub-based contracts will also have to pay liquefaction costs, which would add around $2.25-3.50/m Btu to the cost of supplies.At the beginning of January spot LNG could be bought for $5.70/m Btu in Europe and $6.40/m Btu in east Asia, according to pricing agency Argus Media. That is down from around $20/m Btu in Japan in February 2014. As Petroleum Economist went to press, front-month Henry Hub futures were trading around $2.30/m Btu.

Hanging over all this is an LNG supply overhang that could continue until at least 2020. Wood Mackenzie, an energy consultancy, expects global LNG production this winter alone will be around 3.5m t/y higher than it was last year, thanks to the arrival in the market of new Australian projects. By the summer, the overhang will rise to around 10m t/y as Chevron’s Gorgon project and Cheniere’s Sabine Pass ramp up. More LNG from Angola and possibly even Yemen could also add to supply.

The market won’t be able to absorb all this. So Asian spot LNG prices – which traded close to crude parity throughout the fourth quarter of 2015, at $7.50-8.00/m Btu, will continue to soften through to the summer, says Wood Mackenzie. This should send more supply to northwestern Europe. The arrival of those extra cargoes – amounting to about 2.2m t/y more LNG than last year – and falling prices for Russian oil-indexed pipeline gas will put much more pressure on European spot prices.

Prospects for consumption growth aren’t looking good either. LNG demand in Japan, the world’s largest buyer, peaked in 2012 in the wake of the Fukushima nuclear disaster. But as nuclear plants come back on line and a new drive for renewable energy capacity in the country gets underway Japan’s LNG needs will diminish further.

China and the Middle East are likely to emerge as the main centres of demand growth in the next 25 years, both overtaking the EU in gas consumption terms, believes the International Energy Agency. Thanks to Brent’s slump and the arrival of US LNG, they should enjoy an era of cheap supplies. The delay to Sabine Pass won’t matter for long – the buyer’s market is here.

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